American politics

Wages v profits

Higher profits aren't free either

I REALLY like Adam Ozimek's blogging, but sometimes he writes things that I don't really understand. The other day, he wrote a post titled "Higher wages aren't free". The post rebuts people who argue that "employers in some industry should raise wages":

You can see this in the common refrain that workers would be better off if we had a vastly more unionized economy. Maybe workers would be better off, meaning those that can get jobs would gain. But if you're going to hold wages above market levels you're going to decrease employment, so you'll benefit workers at the expense of those who can't get a job or who take a lower paying job.

As I understand it, the argument of people who think that workers should be earning higher wages is often that too much of the national income is going to corporate profits, and too little to workers' salaries. For example, the Center on Budget and Policy Priorities used to put out press releases like this one from 2007 noting that during the Bush recovery, corporate profits as a percentage of national income had risen to historic highs, while workers' wages and salary had fallen to historic lows:

SHARE OF NATIONAL INCOME GOING TO WAGES AND SALARIES AT RECORD LOW IN 2006 Share of Income Going to Corporate Profits at Record High By Aviva Aron-Dine and Isaac Shapiro

...• Some 51.6 percent of total national income went to wages and salaries in 2006. This is a lower share than in any of the 77 previous years for which these data are available.

...• Corporate profits captured 13.8 percent of national income in 2006, which is the largest share in any year on record. At this point in the business cycle of the 1990s, corporate profits were receiving less than 12 percent of national income.

A glance at the most recent stats for the fourth quarter of 2010 shows the situation seems not to have changed much. Workers' wages and salaries actually fell to 49.8% of national income. Profits, meanwhile, were at 12.9% of national income. CBPP includes a nice chart showing the comparison from 1929 through 2006, and it shows that corporate profits in the 13% range are pretty well on the high side, associated with fat and happy years like 1955 and 1965. They seem out of place in a high-unemployment mediocre-growth year like 2010. Wages and salaries at less than 50% of national income don't seem to have ever occurred before since the table begins in 1929.

Some of the deterioration in wages can be accounted for by rising health-care costs, as companies compensate workers with expensive health insurance rather than salary. But not much. "Total compensation", which includes insurance and pension premiums as well as the employer's share of payroll taxes, was 62.2% of national income in the last quarter of 2010, which is lower than it ever was between 1965 and 2006. In the halcyon days of the 50s and 60s, wages and salaries were above 55% of national income, and we had full employment. It's not clear to me what is so illogical about the idea that in a more heavily unionised economy, more of the price of a widget would go to wages, and less would go to profit. On the argument that higher wages for unionised workers would push wages down for non-unionised workers, it's equally possible that they can push them up, and there's evidence for both cases. And I don't think the claim that higher wages always mean less employment is as universal as Mr Ozimek makes it out to be. It assumes that if companies can pay lower wages, they will choose to use the extra profit to hire more people. At the moment, they don't seem to be doing that. Corporate profits have recovered to extremely high levels, but employment is growing very slowly.

It's true that if wages are higher, then when employers face choices between, say, investing in mechanisation or hiring more workers, they'll be less likely to hire the workers. But if I understand the higher-wages side's argument correctly, it goes something like this: intensifying pressure for higher corporate profits has combined with weak labour bargaining power (in part due to the decline of unions) to depress wages. This has depressed buying power, threatening growth. Over the past decade the Federal Reserve responded by keeping credit cheap, allowing consumers to borrow money to pump up the economy. That led to a credit bubble and a real-estate bubble that popped in 2008, with devastating results. Basically, too little of GDP is being paid in wages to sustain adequate demand; for a while, we made up the difference with credit, but that turned out to be unsustainable. By rebalancing national income away from profits and towards wages (through, for example, stronger collective bargaining), we could re-establish adequate demand to fuel growth, which would lead to higher employment, rather than lower. This argument may be wrong, but Mr Ozimek doesn't seem to be taking it on its own terms.

I understand the dynamic you are describing, and I think both you and Ozimek are making valid points. Ozimek is correct in saying that, assuming that no further efficiencies can be wrung out of the workforce, then increasing labor costs will end up being balanced out by reduced hiring, in order to keep profits at the same level. of course, your point is also correct. By not paying sufficiently high wages, companies are reducing the purchasing power of their employees and indirectly reducing demand thereby.

The factor you are overlooking is the supply side of labor -- with an estimated 13 million unemployed, there is a huge supply of substitute labor that would be happy to work at the lower wage, therefore there is no reason for employers to raise wages. Yes, it may be beneficial for all industries to have a wealthy consumer as its customer base, but if labor is willing to work for less, there is no pressure to increase wages. In any event, even if employers are handing out wage increases to stimulate demand, I am not sure if this leads to sustainable growth -- employers are essentially giving workers money so that they can recycle it right back to the employers. Moreover, there is a very good chance that it would not lead to any growth at all -- if overseas competitors can provide the consumer comparable substitutes at a lower cost, then the wage increase would simply make the employer less competitive rather than acting as a stimulus.

You are making an assumption that unionization can occur universally across a particular economic sector (like all of Walmart, Target, K-mart, etc.). As Southwest Airlines has shown, a single non-union holdout can end up with a substantial economic advantage over competitors, and drive their unionized competition into dire straits.

M.S. (The Economist) wrote: May 11th 2011 9:20 GMT
"I'm not really clear on what problem a higher investment rate by American workers is supposed to solve."

I believe the reasoning is based on the belief that there is more than one way to profit from your employer. You can be directly compensated via wages, but it is also possible to join the capitalists and invest in companies, in many cases via a 401(k) or IRA. If a service worker invests a portion of their income (like periodic 401(k) investments from each paycheck) then over time they grow their investment such that they reap benefits from corporate profitability.

Like the old saying goes, if you can't beat 'em, join 'em -- if industries are going to try and maximize their profits by increasing productivity and cutting costs, then it behooves a worker to try and hop aboard the bandwagon so that they can participate in the benefits the best they can. It doesn't necessarily take much to start an IRA or 401(k) snowball, if you have a long time horizon.

One can survive on a very modest income. I put it to you that as a single person (sharing an apartment), one can get by on less than $6,000/ year of consumption (maybe $8,000 in a more expensive city).

Invest the rest - in education, in property, etc. The prosperity enjoyed in the developed world is outrageous. I get by (as a student) with second hand furniture, second hand clothes, self-prepared food, no alcohol/ cigarettes and public transport. Over 2/3 of all spending is rent and utilities. That's how I invest in my education.

Once you get rich, you don't have to be so tight. But in the opulence of the western world, all it takes is a little modesty to invest in the future (assuming you don't suffer from terrible ill-health).

Why not put some limits on the free flow of capital, particularly hot money, as was once done under the Bretton Woods system and which is still practiced by China? The liberalization of capital was undertaken under the assumption that since globalized goods are a net asset, globalized capital must be as well. So far, the theory has been a stunning failure, and on top of depressing wages has allowed corporations to prop up or assault weak governments in order to promote the business environment they want in those countries.

Chestertonian, I agree that competition due to globalisation accounts for a significant part of the stagnation in wages in the US, but I think the decline of workers' bargaining power accounts for a lot too, and perhaps for much more. When you talk about "shifting factories abroad" you're talking primarily about manufacturing. But 80 percent of US jobs are in the service sector, according to the Cato Institute's Daniel Griswold:

Service sector jobs are hard to export, and workers there tend not to be in competition with foreign labour. If Walmart floor workers organize and get 10% raises, Walmart can't shift its US stores to China. They may have to raise prices somewhat, but competitive pressure will limit that; some of the wage increases will come out of profits. Then, higher prices may cause them to lose some market share to K-mart...unless K-mart workers organize too. Lower profits will result in less investment and less growth...unless, again, the same thing is happening to their competitors. In service sectors, a pan-sectoral increase in unionization could plausibly just shift revenue from profit to wages without reducing overall employment.

The problem isn't lack of unionization, it's that large companies, sometimes explicitly, but usually implicitly, are subsidized by the government. They swallow up competitors, decreasing competition in labor markets, leading to lower wages and higher profits.

During the 50's and 60's, the same situation occurred, but unionization led to a higher standard of living for workers than today. The result was that upstarts emerging markets, such as Japan, Taiwan and South Korea, took vast amounts of market share from these corporate dinosaurs. The high-tech revolution and union-busting stemmed the bleeding, but the core cause still exists today.

Expect 21st century American corporations to demand more subsidies and greater sacrifices from labor to compete with their foreign rivals, while BRIC countries continue eating away at American market share.

I'm not really clear on what problem a higher investment rate by American workers is supposed to solve. There's no shortage of investment capital in the US. If anything there seems to be an excess of capital chasing a lot of implausible investments. And if workers had saved more of their money over the past decade, there would have been even less consumer demand and lower growth. Low growth rates mean whatever money workers invest will grow slowly. Why is this good for workers or for the economy? For individual workers, it is sound advice to save and invest for a rainy day; as aggregate macroeconomic advice I don't see what this is trying to accomplish.

There is a book called Saving Capitalism from the Capitalists by Rag Rajan, the University of Chicago economist who has been under fire recently for advocating the idea that government interference in mortgages was a proximate cause of the 2008 crisis, that deals in-depth with the relationship between corporate subsidies and their distorting effects on the economy.

In this case, shareholders and officers of American corporations are better off with corporate subsidies, but at the expense of American workers and the competitiveness of our economy.

I don't think that's the point I'm trying to make. To use a rough example, my point is that companies like GM or GE either explicitly or implicitly receive subsidies from the government, in the form of direct cash infusions in GM's case or lenient tax laws in GE's case, which bolsters their bottom lines.

The rationale is that they can now compete more effectively with foreign companies, but the price of this is that they can draw talent away from smaller companies unable to extract these types of subsidies. While some workers may do better, overall there is less competition in the labor market, lower average wages, and more profits accruing to large corporations. Whether American works save or invest is irrelevant.

The ironic point of the above rationale is that as labor markets ossify, and workers go where they can find security rather than where they are most productive, and as businesses structure themselves to earn subsidies rather than to increase economic value, American companies become less effective at competing with foreign companies. As I said, stockholders and corporate officers win, but at the expense of everyone else.

You wrote: "Another way to think of it is that international investment capital can go anywhere. If higher profits can be had in union-free or low-wage countries, the U.S. is not where factories will be built."

Higher profits aren't earned abroad because of unions or wages, but because corporations without subsidies have to be more efficient and effective, and will thus increase market share over time. Look at Japanese automakers and Taiwanese electronic manufacturers in the 1980s.

The solution to the problem is to end corporate subsidies, and force American companies to live, and just as frequently to die, by their economic viability. Good luck with that.

For non-trade-able goods and services, unionisation could extract higher wages, with costs being split between owners of capital and consumers. That might boost demand for consumer goods and services; the net employment effect could be positive or negative.

In the trade-able goods & services sectors, unionisation would be less ambiguously bad. In highly competitive global markets, international firms invest where they can make the greatest returns. They do so in the US because of the excellent skills base, infrastructure, industry clusters and market proximity. But, with artificially increased labour costs, these industries would see reduced investment, employment and production in the US.

@doug374 : "The failure of capital controls under Bretton Woods is a major reason for its collapse. I don't think a new and improved Maginot Line is going to work, especially in an era increasingly international banking."

My understanding of the collapse is that a gold standard-bound dollar as the reserve currency in a system of fixed exchange rates gave too little leverage for devaluation in the face of economic crisis. I don't see any reason why unrestricted hot money and the free float of currencies are mutually inclusive policies.

What is the purpose of banking? Is it primarily to fund economic activities that produce new products, or is complete freedom to engage in usury that makes no contribution to the physical economy an equal goal of the banking system? If you assume as I do that the former is true, certain restrictions make sense. One would be limitations on hot money. If companies want to invest in a country's physical economy, that is all well and good. But if those with capital don't believe they can earn long term profits in a country and instead see opportunity to earn money through speculation, there should be reasonable limits on this activity. Moreover, the tax code should be restructured so that domestic companies don't have incentives to ship operations into overseas tax havens.

The failure of capital controls under Bretton Woods is a major reason for its collapse. I don't think a new and improved Maginot Line is going to work, especially in an era increasingly international banking.

I'm not really clear on what problem a higher investment rate by American workers is supposed to solve. There's no shortage of investment capital in the US. If anything there seems to be an excess of capital chasing a lot of implausible investments. And if workers had saved more of their money over the past decade, there would have been even less consumer demand and lower growth. Low growth rates mean whatever money workers invest will grow slowly. Why is this good for workers or for the economy? For individual workers, it is sound advice to save and invest for a rainy day; as aggregate macroeconomic advice I don't see what this is trying to accomplish.